Tom Adams: Resolving Underwater Mortgages and Eminent Domain

Tom Adams, an expert on securitization spoke to Alternative Banking on the use of eminent domain to help distressed homeowners who are “underwater” on their mortgages and the communities.

The Problem: Ever since the financial crisis, millions of homeowners owe more on their mortgages than their houses are worth. This is called being “underwater” on the mortgage. In addition to causing financial distress, this also makes it difficult for them to move if, for instance, they find an attractive job elsewhere. Foreclosures also cause a blight on the entire community.

The Solution: There is broad consensus that the only effective way to address this would be to reduce the amount owed on the loans. Some people argue that this shouldn’t be done because of fairness or moral hazard but it is common in similar situations such as corporate loans.

There have been federal programs that were supposed to help homeowners (called HAMP and HARP) but they didn’t allow the amount owed to be written down. There were also ineffective (perhaps by design) and so there are still millions of under-water homeowners five years after this was supposed to be addressed.

What Could Be Done: Some people have proposed that local governments use “eminent domain” to buy the mortgages and write down the amount owed. Under this plan, a city could repossess the mortgages and restructure the terms to get the homeowner above water. Under eminent domain, a city can take property in exchange for “just compensation” Eminent domain has been very broadly applied (including a US Supreme Court ruling “Kelo v City of New London”). It is likely it could be applied to mortgages. This has been promoted by a financial firm called Mortgage Resolution Partners and some related private equity firms. The city of Richmond California is trying to do this. They have identified about 600 loans in Richmond that would qualify. Wall Street firms have reacted very negatively to this idea. They’ve tried, unsuccessfully so far, to squelch it in court and have also applied intense political pressure. San Bernardino County considered this course and backed off. But the City of Richmond is proceeding.

The good:
It is possible this could work and give the homeowners relief at no cost to the community.

The bad:

• It is not clear it will work. One big caveat is that it requires a judge to deem the “fair market value” of the mortgages, much less than the face amount – even for mortgages where the homeowner is making their payments.
• Eminent domain has a very checkered history. It is not clear we want to endorse its use, even if it would have a good effect in this case.